Scott Trench is the author of “Set for Life,” CEO of BiggerPockets and co-host of the “BiggerPockets Money” podcast. Trench has focused his career on helping ordinary people use real estate investing as one avenue for building wealth.
Recognized by GOBankingRates as one of Money’s Most Influential, here he shares why real estate investing can be so risky, the best property types to invest in and what it will look like when the real estate bubble bursts.
What do most people not know about real estate investing that you wish they knew?
I wish that people knew that real estate investing is a double-edged sword. It’s a powerful way to build wealth over the long term and accessible to most Americans earning a median or higher income. Yet, it is also a dangerous game where, as investors, we play with big numbers and assume legal, operational and financial risks. This is a business that requires, literally, hundreds of hours of self-education from the investor prior to getting started. Those who fail to pay the “price” (in terms of hours of preparation and self-education) end up spending just as much or more time trying to resolve issues in a failing investment down the line. Don’t get into real estate investing if you aren’t willing to invest the time up front to learn this business.
What are the best types of real estate investments to make in 2022?
I think that the best type of real estate investments to make in 2022 are the same as they’ve always been: plain, vanilla, long-term rentals comprising single-family rentals and small multifamily rental properties like duplexes, triplexes and quadplexes. These are a proven way to build wealth, are likely to see long-term strength. Those who buy in desirable locations in markets with strong long-term growth prospects and responsible amounts of leverage (or with all cash purchases) are likely to see a very satisfactory return over the long term, relative to other asset classes.
Which investments should they avoid?
I think that investors should avoid investments that are time bound. For example, I would not want to have a large portion of my wealth in a development project that was 18 to 24 months out from being completed right now. I think that investors in those types of projects are assuming a tremendous amount of risk — interest rates could be far higher in 18 to 24 months than they are today, and that can depress prices, or make it difficult to refinance the property or investment down the line. Of course, that logic works both ways; and, if interest rates come back down quickly, these types of investments might perform even better.
When (if ever) do you think the real estate bubble we are in will burst?
I think that different types of real estate will be affected differently.
I think that, sadly, those at the highest risk are middle-class American homeowners. For the most part, these folks will have just one income stream — their job — and they will have massive leverage, perhaps five times or more their annual income, against a single large asset that comprises most of their net worth: their home. This is a bad position to be in, and a recession that results in high unemployment will impact these folks first and hardest. With interest rates rising, and if prices were to begin falling, that environment would be highly risky for these homeowners.
After this, I think that your institutional investors and syndication investors are at the next highest risk. Rising interest rates are likely to impact cap rates on properties, which will compress values and limit exit and/or refinance options. A lot of these investors have enjoyed well over a decade of rising prices. When interest rates fall and real estate assets are scarce, asset values soar. The more money these institutions raise, the more soaring property values they can scoop up, and the more carried interest the deal sponsors make. This has been a big party for many years. I think that this asset class — and I broadly bucket large multifamily, NNN and other such real estate into this category — is much more exposed to rising interest rates than people think, and there could well be some pain here.
Last, I think that your small mom-and-pop investors are likely to be affected. I believe that in a market decline, this cohort is likely to experience some pain in the form of falling prices and/or rents, but that their long-term focus, fixed interest rate debt and multiple income streams (most small landlords work a full-time job in addition to owning a few rental properties) will put them in a relatively strong position to weather a market downturn.
I think that a lot of people dismiss the actions of the Federal Reserve right now. They feel that they are all politicians and won’t allow the economy to slide. I’m not so sure. Going back in time to the 1970s and 1980s, we’ve seen that the Fed is willing to push interest rates as high as they need to go to fight their first enemy — inflation– and that they are willing to conduct brutal monetary policy that affects jobs to do that.
I also observe that the federal minimum wage has not increased since 2010 — we have the lowest real minimum wage in this country that we’ve had in nearly 50 years, since the 1940s and 1950s. It’s hard to see how unemployment can increase right now in a meaningful sense when the minimum wage is this low.
Instead, I think that we will simply see real wages fall relative to inflation. That’s really important for investors, because the Fed’s dual mandate is to keep both inflation and unemployment low. Unemployment is likely to remain low simply due to the fact that the minimum wage is so low, giving the Fed wide room to run in tackling inflation — again, what I like to refer to as their “first” enemy.
Last, I wonder, with the Republicans predicted to pick up a lot of seats in November, whether the Fed is likely to attempt to stimulate a Biden Administration economy at this point. If I’m (Fed Chairman) Jerome Powell, my task is clear: Beat inflation. It’s not to save the economy to support the Biden Administration. I can’t really see a political advantage for him in doing that. Yet more reason for Powell and the Fed to go after inflation with a single-minded focus.
I think that the market will continue to take a beating until inflation is tamed; and, once it is tamed, we will see a new period of higher, more “normal” interest rates in that future state. Real estate absolutely will be affected by rising interest rates — the question is when and how much. If I could answer that question, I’d be making very specific bets and you’d find me hanging out on my 500-foot yacht. I can’t answer that question. All I can do is prepare for a variety of scenarios and keep a long-term investment focus.
Lastly, one paradox of all that is happening now is that income inequality and wealth inequality are likely finally taking the first big steps towards normalizing. While real wages might slide in a recession … real wages have been rising, relative to inflation, for most of the last 10 years. That’s true for the average and the median American, but not popular to point out. On the flip side, wealth inequality skyrocketed as asset prices inflated with low interest rates. Currently, real wages are still at relative highs, and asset prices are finally moving back towards what seem to be more sustainable valuations. That’s going to reduce wealth inequality in this country.
Something to ponder.
Jaime Catmull contributed to the reporting for this article.
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